payments to former LLC member the year after the LLC is sold

Question

I have a new LLC client (multi member and it is taxed as a partnership). Two partners. In 2020, they had bought LLC that they both previously worked for. It is an architecture firm. One of those two partners was an individual client of mine for about 15 years

Anyway, in 2020, it was just one of these 2 partners as 99% owner and the two partners that were bought out as .05% owners. Even though I did quarterly estimates for 2021, I had no idea that they were still paying out to the two previous owners of the LLC from when they bought it.

The prior .05% partners did not have their 2020 K-1s marked as final. Didnt realize that until today. Their capital accounts were zero, but it still had an ending capital percentage of .05% at the end of 2020.

So, my questions are:

How does the $60,960 in payments to the prior partners get treated. In 2020 it was guaranteed payments. Which made sense as they were still partners. But now in 2021 they wouldn't be. Unless that is why the 2020 K-1 wasn't marked as final and I am still supposed to issue a K-1 with the $60,960 as guaranteed payments, but no other activity on the K-1.

Or do I issue a 1099 to that partner? I don't think it would be a 1099-NEC. Maybe Box 3 on a 1099-MISC?

I asked them now for a copy of the sale. So I can see if it has a breakdown of what they paid for. Mainly to see if part or all of these are Section 736 (b) payments. I assume they paid something for the assets and something for the clients. So it may be a combination of Section 736 (a) and Section 736 (b). There is nothing on the 2020 K-1s to the outgoing partners that make it look like there was a sale. Nothing on Box 9c or Box 10 of the K-1

I feel like a dope for not realizing they were still paying the old partner in 2021. But, when i did the estimates, I just had a P+L Total, not a P+L detail where I would have then probably noticed a category for this.

Any help on this = I greatly appreciate it

qbteachmt · Accepted Answer

You need to refer to the Sale Date. That way, you can determine if you have partner payments or installment payments for the sale.

Payments after the sale date, from the LLC, are not to a partner. They are on behalf of the partners that exist in the new relationship, and that means they would be considered as personal taking, used to make a payment that is outside of the LLC. The LLC didn't sell itself, in other words.

The new partners can use the resources from their LLC for any personal thing they want to, including to pay for their ownership in the LLC because they didn't already pay for it personally, but are making payments. Or, to buy a boat. Or, for a vacation.

Perhaps the sale documents includes an accrued AR, and those payments are representing that carry over, such as:

I sell you a business with AR yet to be collected, and you will pay me over two years as that AR comes is, up to an amount we agree on (giving you consideration for value over time, noncollectables, and a discounted rate for your time and efforts to collect).

Perhaps the sale document includes Customer Prepayments, and until that work is done and the funds are released, the LLC is sitting on client money. This is like selling a property management firm with tenant prepayments in trust. When you sell that type of business, you have to evaluate whose money is on hand and why, as to an Asset or a Liability, against work to be performed or funds to be refunded. This also will vary by State. In my State, architects do not have to maintain prepayments in trust, but you sure would not want to sell the practice and not also deal with customer prepayments in that sale agreement. You might have some really mad customers, when you tell them, Sorry, your money went with the previous owner, so we need to be paid in full and don't have your retainer to apply.

DTNY07 · Answer

I realize now that I need more information.  I asked the client for a copy of the sale agreement and the partnership agreement.  As you can see, I haven't dealt with any sales of partnership interests before as I am clueless.  While I do have partnership returns, most of the time when they are done, it is the entire business ceasing operations (and not a sale, just going out of business).

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